Europe Markets Tumble as Crisis Jitters Return

By

Ira Iosebashvili And

Matthew Walter

Updated Feb. 4, 2013 4:21 p.m. ET

European stock markets and the euro plummeted Monday as Spain's prime minister was enveloped in a corruption scandal and as worries grew over the Italian general election this month, reviving fears for the region's stability after a period of relative calm.

Allegations of secret cash payments to Spanish Prime Minister Mariano Rajoy and other leaders of his party sent the country's stock market down 3.8%. Ten-year Spanish bond yields—a gauge of investors' tolerance towards risk—rose to their highest level since mid-December. Mr. Rajoy pledged over the weekend to disclose his tax returns and financial assets this week in a bid to quell the scandal.

In Italy, the main stock index plunged 4.5%, as former Prime Minister Silvio Berlusconi gained in opinion polls after he vowed to reduce taxes if his coalition wins in the general election later this month. Many fear a Berlusconi victory would undermine the country's reformist push.

Italy also has been roiled by a financial scandal at Banca Monte dei Paschi di Siena SpA, its third-largest bank by assets, which has said it suffered huge losses in derivative trades. Its shares slid 4.8% Monday.

Some market watchers saw the steep selloff in European assets—coming only a few days after the euro hit a 14-month high against the dollar—as a sign that investors have been jolted out of a months-long lull during which the euro zone had a reprieve from major bad news. While the risks of a euro-zone breakup have melted away since the summer, the region still faces political and financial risks that leave European markets as vulnerable as ever, they said.

"Much of the euro's move has been driven by confidence, which can disappear as quickly as it came," said Raghav Subbarao, a strategist at Barclays in London. "We feel the euro's rise is probably unsustainable."

The euro slid to $1.3516 in late New York trading from $1.3651 Friday.

The Spanish newspaper El País published a report Thursday detailing what it said were Popular Party financial records showing two decades of hidden payments to leaders. The party denied wrongdoing, but Mr. Rajoy didn't directly confront the matter until a nationally televised speech Saturday. Mr. Rajoy invited the press but didn't take questions.

Investors gave him poor reviews when the markets opened Monday.

Mr. Rajoy did respond to reporters Monday during a joint appearance with German Chancellor Angela Merkel in Berlin. Asked whether he still had the moral standing to lead his country out of a deep recession, he said: "I have exactly the same strength, the same courage, and I am just as determined to continue in my position as prime minister to overcome one of the most difficult situations in Spain of the last 30 years."

A little over six months ago, selloffs like Monday's were a regular occurrence, as the region's political and economic problems led investors to fear that one or more countries would exit the euro, or that the currency could break apart entirely. But the European Central Bank's pledge in late July to prop up troubled areas of the government-bond market and stand by the euro brought the first stirrings of investor optimism.

Since then, the euro has enjoyed climb of more than 10% against the dollar, while the Stoxx Europe 600 index has soared.

But on Monday, money moved in a wave from weak European countries to stronger ones: Bonds of Spain, Italy, Greece, Ireland and Portugal all weakened. Those of Austria, Germany, Finland and the Netherlands strengthened.

Spanish 10-year bond yields climbed to 5.30%, the highest since mid-December and up 0.11 percentage point from Friday, according to Tradeweb. The equivalent Italian yield was 0.15 percentage point higher at 4.47%.

In the U.S., the Dow Jones Industrial Average slumped to its first triple-digit drop this year, as tech stocks were particularly weak. The Dow fell 129.71 points, or 0.9%, to 13880.08.

To be sure, some investors, like Paul Lambert, who manages a $400 million currency portfolio for Insight Investment, a U.K. fund manager with around £230 billion ($363 billion) in assets, said they weren't alarmed by Monday's drop, which comes after a steep ascent in asset prices and before an ECB meeting on Thursday.

"There's some concern the ECB will say the euro's recent appreciation is not particularly welcome, and investors are using today's Spain news as an excuse to take profits," Mr. Lambert said.

Mr. Lambert said he would "need to see much more evidence of euro-zone trouble" before selling his fund's profitable position in the euro.

Bank stocks were among the major losers in Europe. In Italy, lenders were hurt by news late Friday that prosecutors had launched an investigation into some of the country's largest banks, according to a person familiar with the matter.

In the U.K., Chancellor of the Exchequer George Osborne announced draft legislation giving regulators new powers to split up banks that don't adhere to rules designed to isolate retail banking from riskier investment-banking activity. HSBC Holdings retreated 1.9%, Royal Bank of Scotland fell 3.5%, Lloyds Banking lost 1.9% while Barclays slid 2.8%.

Corrections & Amplifications Paul Lambert manages a $400 million currency portfolio for Insight Investment, a U.K. fund manager with around £230 billion ($363 billion) in assets. An earlier version of this article incorrectly called the company Insight Investments and said it was a $300 million hedge fund

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